The Prospects For a Further Greek Default
Is Greece on the verge of another default? In short, yes. While the total debt involved may not seem like much to get excited over, there is a potential time-bomb hiding in Greece's balance sheet.
What is a Default?
When a country defaults on its debts, it has several options. It can repudiate its debt, it can repudiate part of its debt, or it can default on part or all of its debt. A default recognizes the validity of the debt, and a country may attempt to repay its creditors in part or fully.
A repudiation of debt means that a country does not even recognize that the debt is valid. This is something that Russia attempted to do in the early 1900s, only to be badgered by France (who held millions of dollars in Czar bonds at the time) until the Russians repaid at least some of the debt.
The Ominous Financial Parallels
It's unlikely that Greece will repudiate its debt since it has a long history of default. The country has successfully defaulted on its debts five times prior to the current crisis (1826, 1843, 1860, 1894 and 1932). This makes the probability of another default not only possible, but probable.
According to Morgan Stanley strategist Kevin Flanagan, "The odds of a Greek default have been increased as of late." This makes complete sense given Greek's poor history of debt repayment.
How Will a Greek Default Affect World Markets?
A default shouldn't affect other European countries much if the numbers are analyzed and no market psychology is factored into the equation. After all, writing off 100 percent of Greece's public and private debt held by European public and private institutions would only cost investors 3 percent of total European Union (EU) GDP. The total value of Greece's commerce only amounts to less than 1 percent of the annual EU GDP.
It's an almost insignificant amount, really. However, market psychology doesn't always pay attention to facts alone. This is the hidden time-bomb that could set off a cascade of disaster.
When newspapers publish disaster stories about the market, the market tends to react badly. Consider that European bank stocks have taken a shellacking over the mere fear of a Greek default.
Another thing to consider is how the debt is distributed among German and other European banks. For example, during the 2008 financial crisis in America, the total losses resulting from bad mortgage loans did not add up to a significant percentage of U.S. or even global GDP.
It was how these loans were distributed, the so-called insurance covering these loans, and the way the financial institutions (as well as the market) priced these assets that made the losses such a big deal.
To be fair, European governments have had two years to prepare for a Greek default. However, even though time has been on Europe's side, Greece isn't the only country that's in trouble. A Greek default could be just the beginning. If investors become frightened about other "on-the-edge" European countries, Greece could be the leader in a pack of defaults.
Imagine the effects of Ireland, Portugal, and Spain defaulting right behind Greece. World markets could drop to their knees. Europe, and the rest of the world, may not be able to sustain several countries defaulting in succession.
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